Current Liabilities
and Payroll
Chapter 11
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11-1
Learning Objectives
1. Account for current
liabilities of known amount
2. Calculate and journalize
basic payroll transactions
3. Account for current
liabilities that must be
estimated
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11-2
Learning Objectives
4. Account for contingent
liabilities
5. Use the times-interestearned ratio to evaluate
business performance
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11-3
Learning Objective 1
Account for
current liabilities
of known amount
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11-4
Liabilities
• Best described as:
– Debts and obligations owed to
others.
• Three primary characteristics:
– They occur as a result of a past
transaction or event.
– They create a present
obligation for future payments.
– They are an unavoidable
obligation.
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11-5
Two Major Categories
Current
Liabilities
Long-Term
Liabilities
Will be paid from current
assets within one year or
the company’s operating
cycle, whichever is
longer.
Due after one year
or the company’s
operating cycle,
whichever is
longer.
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11-6
Current Liabilities
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11-7
On August 10, Swanson Company recorded
$4,000 sales of merchandise inventory on account.
The sales were subject to 4% sales tax. Ignore
cost of goods sold.
Date
Accounts and Explanation
Debit
Credit
Prepare the journal entry to
record the sale.
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11-8
On August 10, Swanson Company recorded
$4,000 sales of merchandise inventory on account.
The sales were subject to 4% sales tax. Ignore
cost of goods sold.
Date
Accounts and Explanation
Aug. 10 Accounts Receivable
Sales
Sales Taxes Payable
To record credit sales and sales
taxes.
($4,000 x 4% = $160)
Debit
4,160
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Credit
4,000
160
11-9
On September 30, Swanson Company owes and
pays a total of $500 of sales taxes to the state.
Date
Accounts and Explanation
Debit
Credit
Prepare the journal entry to
record the payment of the
sales taxes to the state.
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11-10
On September 30, Swanson Company owes and
pays a total of $500 of sales taxes to the state.
Date
Accounts and Explanation
Sept. 30 Sales Taxes Payable
Cash
To record payment of sales taxes.
Debit
500
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Credit
500
11-11
Learning Objective 2
Calculate and
journalize basic
payroll
transactions
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11-12
Accounting for Payroll
• Employees are typically
not paid as they work.
• Employees are typically
paid periodically, after
accumulating a quantity
of work.
• Any time employees
have worked, but not yet
been paid, there is a
liability that must be
recorded.
When employees are
paid, they do not
receive the gross pay
that they have earned.
Employers withhold
amounts that are due to
other parties and the
employee only receives
what is “left over,” the
net amount.
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11-13
Accounting for Payroll
Gross Pay
OASDI
Taxes
Medicare
Taxes
Federal
Income
Tax
State and Voluntary
Local Deductions
Income
Taxes
Net Pay
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11-14
Withholding for Employee Income Tax
Federal
Income
Tax
Top rate of 39.6% on
income > $400,000
State and
Local Income
Taxes
For example, in some states
the state income tax rate is
5%.
Amounts withheld depend on the employee’s earnings
and the tax rates. Employers owe the income tax
amounts withheld from employees’ gross pay to the
appropriate government agency.
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11-15
Withholding for Employee Social
Security and Medicare
OASDI
Taxes
Medicare
Taxes
4.2%
Applied to first
$110,100 of earned
income
1.45%
Applied to 100%
of income
These amounts are due to the federal
government following withholding.
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11-16
Optional Withholding Deductions
• Amounts withheld
depend on the
employee’s request.
• Employers must
forward the voluntary
deductions withheld
from employees’
gross pay to the
designated agency.
Union Dues
Savings Accounts
Pension
Contributions
Insurance
Premiums
Charities
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11-17
Recording Payroll
• This table
Gross Pay
$ 28,580
summarizes the
Withholdings
OASDI
$961
payroll and
Medicare
414
withholdings for
Income Tax
5,716
Health Insurance
645
Smart Touch
Other
60
Learning for
Total Withholdings
7,796
December.
Net (take-home) Pay
$ 20,784
• As shown in
Exhibit 11-2, a Payroll Register is normally used
to accumulate this data.
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11-18
Recording Payroll
Date
Accounts and Explanation
Dec. 31 Salaries and Wages Expense
FICA - OASDI Taxes Payable
FICA - Medicare Taxes Payable
Employee Income Taxes Payable
Employee Health Ins. Payable
Other Payables
Salaries and Wages Payable
To record payroll for December.
Debit
28,580
Credit
961
414
5,716
645
60
20,784
Typically, the payroll checks will be drawn
against a separate payroll checking account
that is only used for payroll.
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11-19
Employer Payroll Taxes
• Employers are also required
to pay taxes separate from the
taxes withheld from employee
paychecks.
1. Employers must “match” the
FICA amounts withheld from
employee paychecks.
2. State & Federal Unemployment
Compensation Taxes
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7.65% of
earnings
up to
$110,100;
1.45% of
earnings
in excess
of
$110,100
6.2% of first
$7,000 of
employee
earnings
11-20
Unemployment Taxes
• Unemployment checks are paid out of
the Unemployment Insurance Fund.
• Companies pay into the fund monthly
(5.6% to the state and 0.60% to the
federal government).
• The rate varies with each company’s
employment history.
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11-21
Recording Payroll
In December, Smart Touch Learning had wages subject
to OASDI of $22,880 (one employee went over the
$110,000 limit). Wages subject to Medicare were
$28,580. FUTA and SUTA were due on $4,000 of wages
paid to a new employee.
Date
Accounts and Explanation
Debit
Credit
Prepare the journal entry to
record the employer’s payroll
taxes.
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11-22
Recording Payroll
In December, Smart Touch Learning had wages subject
to OASDI of $22,880 (one employee went over the
$110,000 limit). Wages subject to Medicare were
$28,580. FUTA and SUTA were due on $4,000 of wages
paid to a new employee.
Date
Accounts and Explanation
Dec. 31 Payroll Tax Expense
FICA--OASDI Taxes Payable
FICA--Medicare Taxes Payable
Federal Unempl. Taxes Payable
State Unempl. Taxes Payable
To record employer payroll taxes.
Debit
2,081
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Credit
1,419
414
24
224
11-23
Internal Controls for Payroll
• Efficiency Controls
– Payroll is usually automated, rather than
prepared by hand.
• Disbursement Controls
– Employees sign for checks or present ID’s.
– Hiring and firing is separated from payroll
preparation.
– Time clocks and direct deposit are also used.
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11-24
Learning Objective 3
Account for
current liabilities
that must be
estimated
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11-25
Accounting for Estimated Liabilities
• Some liabilities are
estimated
– Bonus Accruals
– Vacation and Sick
Leave Accruals
– Pension expense
Accrual
– Warranties expense
Many liabilities are
estimated at yearend, even though
actual amounts will
not be known until
some time after yearend. This is in
accordance with the
Matching Principle.
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11-26
O’Conner guarantees its vacuums for four years.
Company experience indicates that warranty costs
will be approximately 6% of sales. Assume that
O’Conner has sales of $200,000 during 2014.
Date
Accounts and Explanation
Debit
Credit
Prepare the journal entry to
record warranty expense.
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11-27
O’Conner guarantees its vacuums for four years.
Company experience indicates that warranty costs
will be approximately 6% of sales. Assume that
O’Conner has sales of $200,000 during 2014.
Date
Accounts and Explanation
Dec. 31 Warranty Expense
Warranty Payable
To record warranty expense for 2014.
$200,000 x 6%
Debit
12,000
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Credit
12,000
11-28
Learning Objective 4
Account for
contingent
liabilities
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11-29
Contingent Liabilities
• A contingent liability is
a POTENTIAL liability
that depends on a
future event.
• How do we disclose a
liability that might
arise in the FUTURE
as a result of
something that has
occurred in the
PRESENT?
Suppose Smart
Touch Learning is
sued because of
alleged patent
infringement on one
of its learning videos.
This may need to be
disclosed to
investors and
creditors.
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11-30
Contingent Liabilities
• The type of disclosure
of a contingent liability
depends on two
issues:
1. How likely is the
future event?
2. Can the amount of
the liability be
reasonably
estimated?
If the lawsuit against
Smart Touch Learning
is frivolous, it does not
need to be disclosed.
If Smart Touch
Learning is likely to
lose the lawsuit, then it
should be disclosed.
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Contingent Liabilities
This table can be used to determine the proper
disclosure treatment of a contingent liability.
Amount . . .
Probability of future sacrifice . . .
Reasonably
Probable
Possible
Remote
Can be
Estimated
Record the
Disclose the
contingent
liability in the
No
liability.
notes to the
action.
financial stmts.
Disclose the
Cannot be liability in the
Estimated notes to the
Disclose the
liability in the
notes to the
financial stmts. financial stmts.
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No
action.
11-32
Other kinds of Contingent Liabilities
• Co-signing
note
• Lawsuits
• Guarantees
• Environmental
Clean-up Costs
• Forward
Contracts
• Contingent
Payments in an
Acquisition
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11-33
Match the likelihood of the future event with the reporting of the
contingency. An answer may be selected more than once.
Likelihood of Future Event
How to Report the Contingency
Remote
a. Do not disclose.
b. Record an expense and a
liability based on estimated
c. Describe the situation in a not
to the financial statements.
Reasonably Possible
Probable and the amount of the loss
cannot be reasonably estimated.
Probable and the amount can be
reasonably estimated.
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11-34
Match the likelihood of the future event with the reporting of the
contingency. An answer may be selected more than once.
Likelihood of Future Event
How to Report the Contingency
Remote
a. Do not disclose.
Reasonably Possible
Probable and the amount of the loss
cannot be reasonably estimated.
Probable and the amount can be
reasonably estimated.
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11-35
Match the likelihood of the future event with the reporting of the
contingency. An answer may be selected more than once.
Likelihood of Future Event
How to Report the Contingency
Remote
a. Do not disclose.
c. Describe the situation in a note
to the financial statements.
Reasonably Possible
Probable and the amount of the loss
cannot be reasonably estimated.
Probable and the amount can be
reasonably estimated.
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11-36
Likelihood of Future Event
How to Report the Contingency
Remote
a. Do not disclose.
c. Describe the situation in a note
to the financial statements.
c. Describe the situation in a note
to the financial statements.
Reasonably Possible
Probable and the amount of the loss
cannot be reasonably estimated.
Probable and the amount can be
reasonably estimated.
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11-37
Match the likelihood of the future event with the reporting of the
contingency. An answer may be selected more than once.
Likelihood of Future Event
How to Report the Contingency
Remote
a. Do not disclose.
c. Describe the situation in a note
to the financial statements.
c. Describe the situation in a note
to the financial statements.
b. Record an expense and a
liability based on estimated
Reasonably Possible
Probable and the amount of the loss
cannot be reasonably estimated.
Probable and the amount can be
reasonably estimated.
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11-38
Learning Objective 5
Use the timesinterest-earned
ratio to evaluate
business
performance
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11-39
Times-Interest-Earned Ratio
This ratio is used to evaluate a
business’s ability to pay interest
expense.
Times-Interest=
Earned Ratio
(
Net
Income
+
Income Tax
Expense
+
Interest
Expense
)
÷
Interest
Expense
A high ratio indicates that the company is
better able to pay its interest.
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11-40
Times-Interest-Earned Ratio
Times-Interest=
Earned Ratio
(
Net
Income
+
Income Tax
Expense
+
Interest
Expense
)
÷
Interest
Expense
Compute the Times-Interest-Earned Ratio for Green
Mountain for 2011
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11-41
Times-Interest-Earned Ratio
Times-Interest=
Earned Ratio
(
Net
Income
+
= ( $ 199,501 +
=
$ 358,857 ÷
=
Income Tax
Expense
$101,699
+
Interest
Expense
)
÷
Interest
Expense
+ $ 57,657 ) ÷ $ 57,657
$57,657
6.22 (rounded)
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11-42
End of Chapter 11
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11-43